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What On Earth Happened to Stock Markets Today?

On the first official day of trading in 2016, global stock markets were in turmoil. Most notably, the S&P 500 and the Dow Jones Industrial Average (if you must) saw losses of a little over 2% in early going, making Monday the worst trading day to open the year since 1932.

On days like today, the stock market can suddenly be thrust into the national news without a lot of great explanation for what, exactly, happened. So, here’s a breakdown of why stock markets were hit so hard today and what this news might really mean.

It All Starts with China

The primary driver of today’s sharp downturn was China.

The Caixin Purchasing Managers’ Index (PMI) is an indicator of the health of the manufacturing sector in China. The number reflects monthly surveys conducted of companies to get a sense of overall demand, and a number over 50 shows expansion in manufacturing while under 50 shows contraction.

Well, the December Caixin PMI came in at 48.2, which is below the 48.6 figure from November, below what analysts were predicting, and the 10th straight month of contraction. On the whole, it shows a Chinese economy that expanded too fast for its own good, building up more factory capacity than it had demand.

This means that the Chinese economy is likely going to continue slowing its growth for the foreseeable future. If demand still hasn’t even caught up to what manufacturers are currently producing, the prospects for new factories to be built are relatively low.

There was also the decision to peg the yuan, the Chinese unit of currency, at a rate of 6.5 yuan to $1. That move showed a continued willingness to keep the value of the currency low, which could make it difficult to export products to the country.

Why Does China’s Economy Matter to Us So Much?

China is a global driver of a lot of economic activity. Not only is it the world’s second-largest economy behind the United States, but it’s growing a lot faster than America’s economy is. While GDP growth is typically around 2-3% in the United States, figures over 10% are a fairly regular occurrence in China prior to the 2008 financial meltdown.

That huge growth rate was really important outside of China, too, as it meant China needed a lot of raw materials and equipment to fuel that expansion by building more factories and buildings. That meant that, as long as China was growing so fast, there was a lot of demand for oil, coal, steel, and heavy construction equipment.

In recent years, though, China’s economy has been showing signs that it’s slowing down. There are also signs that the breakneck pace that the economy was growing at was actually faster than the growth in demand. So, as noted above, if consumer demand in China still has to catch up to current capacity, it’s hard to see a lot of new factories or apartment buildings being constructed, which is no good for the companies producing materials and equipment used for that.

Markets have slowly been digesting this information since about 2013, making them very sensitive to negative news about manufacturing and growth in China. The Caixin PMI numbers clearly helped trigger those fears and had traders and investors in the United States preparing for even slower growth than they had been expecting.

And China’s Stock Market?

As bad as those Caixin PMI numbers were, the effect that they had on the Chinese stock market was worse. The stock markets in China have been on pretty shaky footing since last summer, and today appeared to show that they may have a way to go yet before they’re out of the woods.

The Shanghai Composite Stock Market Index was cruising at over 5,000 as of June 11 of last year. However, it then proceeded to go into an absolute tailspin and, by late August, it was under 3,000, representing a loss of over 40% and indicating that much of the rapid growth it had experienced was driven by a speculative bubble.

That crash raised some serious questions about the structural health of the entire Chinese stock market, questions that many don’t believe have been adequately answered. In fact, the government went to such great lengths as to halt all trading of stocks entirely in July and only resume trading gradually and with restrictions.

They also designed a “circuit breaker,” or a system to automatically halt trading when losses for the broad index reached a certain point. As luck would have it, today was the first day of the new system, and it halted trading after the index fell 5%. It reopened trading later that same day only to have it halted for good when losses continued after trading resumed and eventually reached 7%.

The idea of a system like this is to interrupt panicked periods of selling and let things cool down, and it could be that when things resume tomorrow everything will return to normal. However, it can also have the opposite effect. Anyone holding shares in Chinese companies is currently experiencing heavy losses and unable to sell their shares. When trading resumes, you could just as easily see everyone to rush to sell stocks quickly while they have a chance and before they fall farther, causing an even bigger crash in the end.

Either way, there’s a lot of uncertainty swirling about China’s stock market that’s exacerbating the concerns about slowing growth and making asset managers the world over pretty worried.

Not JUST China, Though

Of course, there were other factors outside of China, as well. The recent increase in tensions between Saudi Arabia and Iran are certainly troubling for many. In short, Iranians stormed the Saudi embassy in Tehran in response to the execution of a Shi’ite cleric in Saudi Arabia, which prompted the Saudis to cut off diplomatic ties.

These two nations have been fighting an ongoing proxy war in Yemen and throughout the Middle East, so hardening battle lines like these could indicate continued turmoil in the region. That, in turn, could be pretty bad news for global oil supply.

Either way, fears about instability in the region are likely contributing to the concerns about China. Once you have a lot of bad news like this, a lot of investors will start looking to shift assets away from stocks, which carry a lot of risk relative to bonds, into safer assets until things clear up. You also have stock markets that appear to be in the process of pulling back from the huge run they had from 2009-2014, with the S&P 500 falling 2.15% in 2015, so there’s already some negative sentiment in the air.

So, today’s decline is primarily fueled by concerns about China, but it’s also getting stirred up by that news taken in combination with several other factors.

Time to Panic?

In a word, no. Worry, sure, but certainly not panic.

The reality is that this is a pretty bad day for stocks, but it’s just one day. Putting too much stock, pun intended, in a single day’s performance is usually an overreaction. On a day to day basis, the markets tend to be pretty volatile, and unless you’re a day trader, the long-term trends are what should really matter to average Americans. How things are managed in the coming months is what will really matter, not this one-day swing.

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